Annie McQuilken: How to make sure your advisor is no Ponzi

Annie McQuilken

Thursday

Jan 29, 2009 at 12:01 AMJan 29, 2009 at 10:41 PM

The rich history of Lexington, Mass., is usually a source of pride, but one of the town's most famous residents gave his name to some of the biggest swindles of all time. Charles Ponzi lived in Lexington for only a short time, but it was where he was living when his scheme was uncovered.

The rich history of Lexington, Mass., is usually a source of pride, but one of the town's most famous residents gave his name to some of the biggest swindles of all time. Charles Ponzi lived in Lexington for only a short time, but it was where he was living when his scheme was uncovered.

A Ponzi Scheme is a type of investment fraud in which existing investors are paid returns from the money deposited by new investors. As long as the funds deposited by new investors exceed the withdrawals from existing investors, the scheme can go undetected for years.

As the returns claimed are extraordinary, the investors are generally thrilled to keep re-investing, which keeps pay-outs small. Unfortunately, those extraordinary returns exist only on paper, specifically on the false reports they receive from their investment advisor.

The latest Ponzi scheme to be uncovered is astounding in size, scope, and the length of time it went undetected.

Bernard L. Madoff of New York admitted that he has been running a Ponzi Scheme from an investment advisory branch of his brokerage business for decades. Estimates of the loss exceed $50 billion.

Like Ponzi, Madoff claimed to have exceptional returns on investment, and his existing clients became his best source of new clients. Throughout the cocktail parties of New York and Miami, the wealthy told their friends they were missing out, and the friends jumped on board.

Fraud by financial advisors is exceedingly rare. Nonetheless, the tragic losses by Mr. Madoff’s clients are undoubtedly making other people wonder if their financial advisor is acting in their best interest. The following advice can help you protect yourself when working with a financial advisor:

· Check credentials. Investment advisors are regulated by the State of Massachusetts and the Securities and Exchange Commission. Go to www.adviserinfo.sec.gov to view the annual disclosure forms which every investment advisor must submit. You can do a search at www.cfp.net/search to verify the credentials of a Certified Financial Planner.

· Know where your money is. When you hire an investment advisor, an independent financial institution will hold your money. This company has “custody” of your money. Make sure you know which company it is, how to contact the company, and what your account numbers are.

· Read your quarterly financial statements. The firm that has custody, typically a broker/dealer, bank or trust company, is required to provide you with quarterly financial statements. Read them. Most importantly, make sure that these statements are coming to you directly from your custodian firm — not from your advisor. Stay clear of any advisor who insists they be your only source of information about your accounts.

· Know who the advisor is working for. Many financial advisors, such as those who work for large financial services companies, have a fiduciary obligation to their employer, not to their respective clients. When advisors are receiving commissions, clients should be particularly concerned about whether the advice they are receiving is truly objective. Ask your advisor if they are willing to sign a fiduciary oath putting your interests above those of themselves or their employer.

· Know who works for your advisor. Many of the people who lost funds placed with Madoff did not know they had invested with Madoff’s firm. Instead, they invested with an investment advisor who, in turn, invested their funds with Madoff. It is not uncommon for advisors to use sub-advisors who have expertise in particular segments of the market, for example in bonds, commodities, or other specialties. Your advisor should always let you know about these sub-advisors, and be able to explain to you the reasons why they have selected these sub-advisors on your behalf.

· Don’t fall for the free lunch. If something sounds too good to be true, it probably is. You will do better in the long run by following reasonable and prudent investment strategies, and avoiding get-rich-quick schemes. All of us would love to get rich quick, but getting rich slowly is a lot more likely to pay off over time.

Having a financial advisor, even a person with great credentials, is no substitute for staying aware and involved in your personal finances.

Most financial advisors are professional and trustworthy. In fact, they can often catch a dubious investment or fraudulent offer before their clients are swindled.

When people lack the knowledge or skills to stay on top of their personal finances, or the time to appropriately manage their investments, hiring a financial advisor can be a prudent and worthwhile investment.

Annie McQuilken is a fee-only financial planner and investment advisor, and president of Kintyre Financial Advisors, LLC in Lexington. She can be reached at amcquilken@kintyrefinancial.com.